The global order book for new vessels has been hit by the economic fall out of the pandemic, associated supply chain issues, over-supply and reduced demand in sectors such as offshore. However, with a globally ageing fleet and an increasing demand for greener and more efficient vessels, the shipbuilding market is expected to recover and grow at a rate of 5.7% between 2021-2026. This blog looks at some of the risks posed to a buyer under a shipbuilding contract (“SBC”) both prior to and after delivery of the vessel.
During the vessel’s construction, the undelivered vessel (and the builder) pose a credit risk to the buyer. This risk is normally secured by way of a refund guarantee from the builder’s bank, which gives the buyer security for the repayment of the substantial instalments it will pay to the builder ahead of delivery. Should the buyer validly terminate the SBC prior to completion, the builder’s bank will pay the amount of the instalments paid, back to the buyer. Those termination rights should include delay in delivery, failure to meet certain performance characteristics, total loss and (preferably) builder insolvency.
It is important to note the terms of the refund guarantee however and the circumstances in which the buyer can rely on it. The guarantee may not be payable ‘on demand’ and often will only be payable upon the finding of a court or tribunal that the builder is liable to the buyer following the buyer’s valid termination of the SBC. These points are important to consider when the terms of the SBC and the guarantee are negotiated to ensure that they fully reflect the needs of the parties. With increased design risk around new technologies, there may be more discussion around who will bear this design risk (usually the builder), and greater focus on possible default, compensation and security for this.
It should be noted that where the buyer terminates the SBC, it will usually be entitled to recover only the instalments paid plus interest on those instalments. The buyer will not be able to seek damages, even where the fault is that of the builder. This may be a surprise to some buyers.
The SBC should set out the rights of the buyer in the event that the vessel is not delivered within the contractual delivery date. The buyer is often entitled to claim liquidated damages at a daily rate from the builder until the vessel is delivered. The total damages owed are usually then deducted from the purchase price. These provisions (in an English law SBC) will need to be drafted so as not to constitute a penalty. The buyer may only recover damages to the extent that they are in proportion to the buyer’s legitimate interests and are not imposed purely to punish the builder for the default under the SBC. Liquidated damages will not be claimable for ‘permissible delay’ circumstances, such as force majeure, modifications or buyer default (for example, late payment of instalments).
The SBC will also provide the buyer with the ability to cancel the SBC. This right will usually only arise after a significant period of (non-permissible) delay, often stated in the SBC as 180 days. However, the option to cancel the SBC is not without risk to the buyer if the builder is able to show that the termination was wrongful, at which point the builder may be entitled, where the buyer is in default, to terminate the SBC, retain the instalments paid by the buyer to date and sell the vessel.
The vessel’s performance and compliance with the specifications of the SBC will be checked during testing and trials ahead of delivery. This will include ensuring that the vessel meets the required speed, fuel consumption and deadweight requirements, failing which it is possible that liquidated damages are payable or a right to terminate may arise. However, certain issues may only come to light after delivery. The remedies available to the buyer against the builder will be dictated by the terms of the SBC.
Most English law SBCs will seek to exclude the provisions of the Sale of Goods Act 1979 (and other legislation). This will exclude the ability of the buyer to imply terms into the SBC regarding the quality and performance of the vessel. For more on this point please see our previous blog post on the case of Neon Shipping Inc. v. Foreign Economic 7 Technical Corporation Co. of China and another, available here. In this regard, the SBC will usually provide that following delivery, the buyer must rely upon the warranty given by the builder under the SBC (to the exclusion of any other rights or remedies). Most SBCs will provide that the builder will guarantee the vessel’s materials and workmanship for 12 months from the date of delivery and acceptance by the buyer.
Under the builder’s warranty, during the 12 month period following delivery, any defects will be the responsibility of the builder to remedy at its own cost, although the builder will not be liable for any consequential losses suffered by the buyer as a result of the vessel’s non-compliance with the SBC. It is vital that any buyer wishing to make a claim under a warranty in the SBC pays close attention to any formal notice requirements. Whilst a defect may have arisen within the 12 month warranty period, unless notice is given to the builder within that warranty period, or within a short period following the expiry of the warranty period (often 28 days) then the builder may well be released from its obligations to address the defect. The form of notice, who the notice is to be sent to and by what means will be prescribed in the SBC and must be adhered to in order for the warranty claim to be valid. Similarly, warranty notice provisions usually specify the supporting documents that must be provided to the builder in support of the claim. Prompt notification of any issues to the builder will likely also be a term of the vessel’s hull and machinery cover.
Being alive to both the legal and practical implications of the terms of the SBC is essential to ensure a buyer best protects its financial interests during the lifetime of a build project.